What’s Driving Unilever’s $40 Fair Value?

Unilever (NYSE:UL) is one of the leading consumer goods companies in the world with approximately $70 billion in total revenues in 2012. It competes with the likes of Colgate-Palmolive (NYSE:CL) and Procter & Gamble (NYSE:PG) across various product segments, including personal care and home care. Unilever also owns a wide portfolio of food and refreshment items such as soups, ice creams and spreads. Its key competitors in this segment are Nestle and ConAgra.

Driven by product innovation, an expanding geographical footprint and deep penetration in the emerging markets, Unilever’s top line has grown at a healthy pace. It currently generates over 50% of its revenues from emerging markets and is strongly focused in this direction. Although this has fueled the revenue growth, it has also hindered company-wide EBITDA margins, which declined from about 16% in 2010 to 14% in 2012. The company wants to earn as much as 75% of its total revenues from emerging markets by 2020.

With a contribution of about 35% to total company revenues, personal care is the highest revenue generating segment for Unilever. It includes popular brands such as Axe, Pepsodent, Lux, Dove and Sunsilk in deodorants, oral care and skin & hair care product categories. Accounting for approximately 47% of the Trefis stock price for the company, it is also the most valuable segment. During 2010–2012, Unilever’s personal care revenues grew at an average annual rate of approximately 13%, faster than the overall market which registered growth rate between 4% and 5%. Strong innovation and well-supported brands led to the broad-based growth in the division.

The company’s market share in personal care is strong, particularly in deodorants where it accounts for close to 50% of global sales. We expect Unilever’s market share in personal care to continue to rise in the future due to strong brand recall, and high penetration rates across both developed and developing economies.

Unilever’s products are generally available at lower price points compared with competitor P&G. This has helped Unilever see market share gains both in price-sensitive emerging economies as well as developed economies,where consumers have become more price conscious. The company’s focus on beating competitors through lower pricing is also evident in its historical operating margins. Its EBITDA margins in the skin & hair care segment consistently hovered around 16% and 18% during 2008-12, while P&G’s EBITDA margins in beauty products mostly stayed over 20%, contemporaneously. We expect Unilever’s EBITDA margins to remain near current levels of 16% for the rest our forecast period.

Food Division

Food was the highest revenue generating division for Unilever until 2010. However, personal care revenue overtook food revenue in 2011, as the latter grew at a much slower pace. A major part of this is attributable to the offloading of slow growing businesses to focus on faster growing, more profitable ones. With less than 30% contribution, food is now the second highest revenue generating division of the company. Unilever derives about 32% of its value from foods.

Unilever is the global leader in foods such as soups, dressings, savory and spreads. Its portfolio includes renowned brands such as Knorr, Hellman, and Becel. The company’s share of the global grocery market stood close to 70% in 2007. However, it has persistently declined since then due to lower dollar sales amidst the weak economic environment, high promotional activity from competitors and the divestiture of certain food brands. Despite all of this, Unilever commands about 55% share in the global grocery market. Driven by strong innovation, efforts to fill pricing gaps and communicate health benefits to customers, we feel Unilever will be able to protect its market share in the future.

The food division has experienced heavy restructuring in the past years. Charges incurred on the same explain the sharp drop in EBITDA margin from 24% in 2008 to 16% in 2009. EBITDA margins improved thereafter due to efficiencies that ensued the restructuring, although they remained well below historical levels. Unilever continues to restructure its food business. It recently divested slow growing businesses such as the North American frozen foods business, Wish-Bone and Western dressings business, and the peanut butter brand, Skippy. As Unilever’s recent restructuring efforts come to fruition, we estimate its EBITDA margins will marginally improve.

Refreshments Division

Unilever’s refreshments division includes tea, drink and ice cream brands. The division contributes slightly less than 20% to total company revenues of which ice creams account for the majority. Refreshments have performed well in terms of sales in the recent years with revenues increasing from around $11 billion in 2009 to $13 billion in 2012. Led by strong product innovation and geographic expansion, we estimate Unilever’s revenue from refreshments to grow to over $18 billion by the end of our review period.

The robust growth in historical top line came at the cost of margins as Unilever continued to play the lower price card for attracting consumers, especially in emerging economies. This resulted in the decline in EBITDA margins from around 14% in 2008 to about 10% in 2012. We expect only slight improvement in future margins due to the company’s low pricing structure and strong expansion in price-sensitive emerging economies.

Home & Fabric Care Division

Home & fabric care products contribute the remaining 18% to total revenues. Unilever has been focused on aggressive expansion of home & fabric care products in emerging markets. While this has allowed the company to increase its market share, it has also resulted in a sharp decline in EBITDA margins from over 10% before 2009 to about 6% in 2012. We believe Unilever will experience further market share gains as it expands into new geographies. However, this will also limit growth in EBITDA margins.

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